Congress enacted § 6038D of the Tax Code as part of the Hiring Incentives to Restore Employment (HIRE) Act. In a nutshell, it requires certain individuals to report information about specified foreign financial assets. The IRS and Treasury Department recently issued final regulations regarding the reporting for certain domestic entities.

In particular, § 6038D(a) provides

Any individual who, during any taxable year, holds any interest in a specified foreign financial asset shall attach to such person's return of tax imposed by subtitle A for such taxable year the information described in subsection (c) with respect to each such asset if the aggregate value of all such assets exceeds $50,000 (or such higher dollar amount as the Secretary may prescribe).

Subsection (f) notes that, to the extent provided by regulations, the rules apply to any “domestic entity which is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if such entity were an individual.”

Temporary regulations were issued in 2011 that addressed the reporting requirements under § 6038D. Many of those were finalized in 2014; however, the proposed regulation regarding domestic entities—proposed regulation § 1.6038D-6—was not finalized at that time.

That regulation has now been finalized.

The final regulation clarifies the reporting threshold described in § 1.6038D-2(a)(1). Under the new rule, specified domestic entity status is determined without regard to the reporting threshold. As the Treasury notes, “[t]he Treasury Department and the IRS did not intend for domestic entities to apply the reporting threshold described in § 1.6038D-2(a)(1) twice in order to determine their section 6038D reporting responsibilities.” In other words, the reporting threshold is used to determine whether the entity has a filing obligation, not in determining whether it is a specified domestic entity.

The final regulation also eliminates the principal purpose test. Under the proposed regulation, a corporation or partnership was treated as formed for purposes of holding specified financial assets if, among other things, it was formed by a specified individual with a principal purpose of avoiding § 6038D. The final regulation eliminates this subjective approach and abandons the principal purpose test. Rather, the regulation focuses on the 50-percent passive assets or income threshold.

The final regulation also defines passive income. The proposed regulation had listed specific items of passive income. After the issuance of the proposed regulation, however, regulations under § 1472 were finalized in early 2013; these regulations also defined passive income for the purpose of identifying nonfinancial foreign entities. Indeed, the concept of passive income under both § 1472 and § 6038D serve a similar purpose, that is, as the Treasury notes, to “identify entities that have a high risk of being used for tax evasion and to reduce compliance burdens for active entities.” Consequently, the final regulations incorporate some of the aspects of the § 1472 regulations.

The final regulation also clarifies the determination of interests in a domestic partnership. The proposed regulation provided that whether a domestic partnership was a specified domestic entity was to be determined annually. Moreover, a partnership was closely held if “at least 80 percent of the capital or profits interest in the partnership is held directly, indirectly, or constructively by a specified individual on the last day of the partnership’s taxable year.” A commentator objected to this test, noting that it is often difficult to determine the precise capital or income interest of a partner because it may shift due to partnership performance. Nevertheless, the final regulation retains the rule in the proposed regulation for determining if a domestic partnership is closely held.

The proposed regulation also provided aggregation rules for the reporting threshold and passive income and asset thresholds. As the Treasury notes, the final regulations “simplify the aggregation rules by eliminating the reference to treating all domestic corporations and partnerships as a single entity.”

The final regulations also clarify the rules regarding domestic trusts by providing that the term current beneficiary “also includes any holder of a general power of appointment, whether or not exercised, that was exercisable at any time during the taxable year, but does not include any holder of a general power of appointment that is exercisable only on the death of the holder.”

The final regulation is found at 26 C.F.R. § 1.6038D-6. You can read it in the Federal Register (from Feb. 23, 2016) available here.

Note: Section 6038D and its related regulations are very technical. The above is only a summary of the final regulation (and it is only one regulation of several that apply to § 6038D). Consequently, please consult the statute, the complete regulatory regime, and an attorney, if needed.

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